We're living in a golden age of fraud

One of my favorite people, Jim Chanos, has the saying that we're living in a golden age of fraud. I kind of agree with him.

There's a lack of integrity at a lot of companies, and some of the factors making this such a big problem: there's just a lot of easy flowing money. When you're in a period where there's lots of venture checks being written for things and investors are throwing money at anything that's growing, that kind of makes good people do bad things and bad people do worse things. Lots of easy flowing money is not a good thing for integrity.

When you have lots of retail participation in the markets, that can lead to companies or CEOs of publicly traded companies being a little misleading, trying to cheat around the edges to get their stock price up. When you have a weak punishment dynamic with regulators, where you can do wrong over and over again and the fines are kind of minimal, and usually at the corporate level and not the individual level. It's problematic.

It's very sad because it harms a lot of people. But it's great for me because it means I have a lot to write about.

I covered these ideas in a conversation with the team at Wealthion. Watch the full interview: The Golden Age of Corporate Misconduct (Wealthion, YouTube)

Regulators are financial archaeologists

Regulators are in some ways like financial archaeologists, especially financial regulators like the SEC. They're very good at going in and seeing what happened after the fact: telling you who was responsible, sending subpoenas, analyzing the laws. But they're not great at proactively preventing bad things from happening.

One shift I see happening that I think is a big positive: no longer is it just that the company pays a fine. There's been a big push to name and shame executives, find them personally, and give them bad press. I think that's key for improving misconduct.

If a CEO calls the general counsel and says, "I'm thinking of doing this unethical thing, what are the upsides and downsides?" and the general counsel says, "The downside is you could personally pay a big fine, get in a lot of trouble, be named and shamed, and get a director and officer bar for five years." That is much more effective even if the fines are smaller.

The SEC whistleblower program has also changed the game. Instead of doing it out of the goodness of your heart, if you're an executive at a company where there's serious misconduct and you go to the SEC, you can get 15 to 30% of any recovery they levy. People are earning tens of millions of dollars being SEC whistleblowers. That's one of the biggest things in the finance world that's probably shorting behavior.

Because other than that, being a whistleblower is terrible. If you look at the history of whistleblowers, a lot of them get addicted to drugs, get buried in bureaucracy, commit suicide. You've got all the power in the world going against you.

The two kinds of companies I write about

I spend a ton of time looking at individual publicly traded companies to try to assess their relationship with their customers. Because if you delight customers, you might not be a great investment, but you're probably not going to be a terrible one.

On the other hand, there are a lot of companies having good financial results: great customer retention, profitability increasing, but they're just abusing their own customer base. The other category is companies that just have no economic substance: a shell of a company pretending to have something substantive and lying to retail investors to generate hype.

Root Insurance and The Joint

One of the big companies I wrote about was Root Insurance, which went public in October 2020. They're a car insurance company. Their pitch: download our app, we track your location 24/7, and based on your phone's GPS data we can determine whether you're a good or bad driver. Investors were eating it up: all their metrics were up and to the right.

I got interested because I saw one consumer complaint about them. I went to state regulators and sent FOIA requests for consumer complaints that consumers had filed with Root. It was remarkable: hundreds and hundreds of pages of consumers saying, "I signed up at a great price, but they keep increasing my renewals 50% every year, and they make it really difficult to cancel."

Root's underwriting greatness isn't actually that they're a great underwriter. It's that they lure customers in with cheap auto insurance and then abusively renew them. During the pandemic, when no one was driving, every other auto company was lowering rates for customers. Root was making rates go up, up, up. And in tandem with that, making it really difficult to cancel.

One of the documents I got from the FOIA was a letter from a lawyer who represented Spanish-speaking clients. He wrote the Georgia insurance commissioner saying, "I have about 10 Spanish-speaking clients, they all have Root Insurance, have no idea how to cancel, and they keep getting gouged."

The Joint ran the same playbook. They're a franchisor of chiropractic clinics: you'd pay $80 a month for adjustments. To cancel, especially in the pandemic, there was no phone number you could call, no way to cancel online. You needed to drive in person to your chiropractic clinic and fill out a two-page form. People were saying, "I've done this and I still can't cancel."

Making it impossible to cancel helps your retention and helps your financial results. So every investor thinks your value is increasing. But it's actually dramatically decreasing because you're tarnishing your entire future for a short-term benefit. You can't build a multi-billion-dollar business if 90% of your customer base is pissed off at you and trying to cancel.

AgeEagle and Embark

Then there's AgeEagle Aerial Systems, at one point a billion-dollar company. They described themselves as pioneering advanced commercial drone technologies: building drones that could deliver packages, look at marijuana fields. Within an hour of reading their SEC filings: they have one employee in research and development, they spent a total of $200,000 on R&D over the last five years. Comical numbers for a billion-dollar company.

One photo we showed was their drones on their YouTube page: it was literally a remote-controlled airplane with a GoPro attached. That's what they called a revolution in aviation drone technology. The company reached a billion-dollar market cap. How does that happen? The chairman's daughter created a locked YouTube video with the Amazon logo next to the AgeEagle logo to make it seem like a partnership was coming. Then stock promoters started saying, "We found this locked YouTube video where the chairman's daughter is hinting at an Amazon partnership." And you're getting gullible investors to think they found the next big thing.

Then there was Embark Trucking: a 26-year-old CEO, software for autonomous trucking, went public via SPAC at a multibillion-dollar valuation. They said they owned no patents, even though competitors each owned hundreds. Usually if you've got a burgeoning startup with new technology, you hire an adult in the room. They hired a famous engineer from Tesla who left after six months. No one ever does that. No one moves to join a new company and quits after 18 months or less unless something is really bad.

If you looked on Glassdoor, the CEO had 50 five-star reviews. But all the reviews were posted literally the day the SPAC merger was announced. These aren't legitimate employee reviews saying "we love the CEO." This is the HR office saying, "Everybody go leave a five-star review: we got a SPAC deal." Embark is down over 99% since its SPAC merger.

How I find companies: the SEC EDGAR full text search tool

I'm very simple. I'm addicted to Twitter, and I'm on there two, three hours a day, following thousands of people, bookmarking 50 tweets a day. It might not be healthy, but it's a great way to find ideas. I also spend a lot of time on YouTube watching videos of people complain about companies. YouTube learns what you like.

But one of the most systematic tools I use is something I call "board left." Anytime I see a recent IPO or SPAC deal collapse, falling 90% in a year or six months, I look at all the board members and say: you served on the board of this failed company. What other boards do you serve on? You'd be amazed at how often it's: this person serves on three boards, the first two were SPAC deals that fell 90%, and their third is a $2 billion recent IPO. Like attracts like.

The tool that makes this possible is the SEC Full Text Search tool: a public site by the SEC that lets you search all SEC filings in existence. I take each board member's name and put it into the search. That means I can see every time that board member has been mentioned in any SEC filing since 2001: every other board they've served on, the ones they've resigned from, times they've been mentioned in other companies' press releases. If board members of a big company have been involved in a lot of failed companies, penny stocks, or promotions, that is a huge, huge red flag.

Try it yourself: search any board member name at efts.sec.gov (SEC EDGAR Full Text Search) -- every SEC filing since 2001.

I also look through the 300 or so publicly disclosed recent executive resignations every week, and I try to find the five or ten most egregious: a CFO who leaves after just four months, or a company that's had three different heads of HR in the last four years. That's a sign of something being wrong at a company.

And I've been doing this long enough that people send me inbound tips. I function almost like a journalist: proactively finding this stuff, and getting inbound tips from readers.

FOIA requests: the gold standard for understanding a company

One of the beauties of being a US citizen is that the government has an obligation under the Freedom of Information Act to share public records with us. Any US citizen can go to a state regulator or federal regulator and demand public records. Part of public records are internal emails, and part are consumer complaints that people have filed with their insurance commissioner or state attorney general.

The laws vary a little by state: not all states will give records to you quickly or without cost. But because I've done this so much, I know which states are more responsive. Give the agency a specific request for records, and within 30 or 90 days they need to get back to you.

This is the gold standard for understanding a company's relationship with its customers. You can read consumer complaints online, but that's not a hard document. You don't know if a competitor wrote it. Going to a state regulator and getting consumer complaints, you can often see the company's response too. That tells you everything.

Eighty percent of the time there's probably nothing there. Ten percent of the time you find more mild stuff. But every once in a while you find really, really egregious stuff that I just know is going to have a big impact on the future of the business, and that Wall Street just isn't picking up on yet.

What any investor can check

The easiest thing is to read SEC filings and see if you can understand what a business actually does. Read the investor presentation and see if it makes sense. If you can't understand it, that's generally a big problem.

Google every board member. Use the SEC Full Text Search tool: search every board member's name across every SEC filing since 2001. If you see board members with histories of failed companies, penny stocks, or promotions, that is a huge signal to avoid.

Look for executive turnover. A CFO who leaves after four months means something bad is going on. Multiple heads of HR in a few years. Same thing.

Read consumer reviews. For consumer-focused businesses: Wall Street likes to hire consultants and say they have a proprietary model. I think just going to YouTube and typing in a company's name plus "complaints" goes a long way. You wouldn't want to invest in a pizza company without tasting the pizza. Just having a little bit of initiative to look into the board members, look into the executives, see their history, see who the auditor is, and that goes a long way.

The most egregious misconduct I've found is almost entirely document-based. You can learn everything by reading the company's filings, being inquisitive, curious, applying scrutiny, and filing FOIA requests with state regulators.

If you know of a public company that's misleading investors or harming customers, email me or DM me on @StockJabber on X. Or look up The Bear Cave and reply to any of the emails there.